RBI Begins to Cut Interest Rate, How Much More ?

January 15, 2015

In an out of monetary policy review decision, the RBI today lowered the key benchmark repo rate by 25bps to 7.75% with immediate effect. Consequently, the reverse repo rate and marginal standing facility rate are also lowered by 25bps to 6.75% and 8.75% respectively. The cash reserve ratio (CRR) stands unchanged at 4%.

In the statement issued today, the RBI stated that inflationary pressures have ebbed since July 2014 from a combination of factors – sharp fall in vegetable / fruit prices, lower pressure from cereal prices and a large fall in international commodity prices. Alongside this, core inflation has also remained muted. RBI stated that

on current policy settings, inflation is likely to be below 6% by January 2016. These developments have provided headroom for a shift in the monetary policy stance.

We believe that this is a beginning of a big rate cut cycle. We expect a further 125 bps over the next 12 months, cumulative 150bps in this cycle (compared with our earlier forecast of 50bps rate cuts). Our rate cut forecast is predicated on our view that CPI inflation will stay at closer to 5% in most of the calendar year 2015, as the reduction in fiscal deficit, sustained deceleration in rural wages and lower global commodity prices will mean that inflationary pressures in the economy will be contained. From an underlying cost of capital perspective, we expect deposit rates, which have been running above policy rates, to decline by a further 175bps to 200bps (cumulative 200bps, with banks having already cut deposit rates by 25bps).